Business

Inflation is at a 30-year high – what does this mean for you?

With inflation now at 7 per cent, where are price rises steepest, what’s causing them, and how long will they last?

Illustration by Simon Brader / Ikon Images

The Consumer Price Index, the UK’s main measure of inflation, has reached its highest level since March 1992. The Office for National Statistics (ONS) announced this morning (13 April) that the CPI increased from 6.2 per cent last month to 7.0 per cent in the 12 months to March.

What is inflation?

Inflation describes how much the cost of living is increasing (if it’s decreasing, it’s known as deflation). In the UK, the main measure of inflation is the CPI. The ONS tracks the cost of living through the prices of items in a hypothetical “basket of goods” that includes everyday products and services. The most recent basket of goods included staples such as a large wholemeal loaf and olive oil, but also added new items, such as meat-free sausages and canned pulses. Doughnuts, men’s suits and coal were removed.

Why is inflation so high?

The ONS said the main reason inflation rose so fast in the year to March was the cost of housing, which rose 1.5 percentage points, and transport costs – which were fuelled by the price of petrol and second-hand cars. Average petrol prices in March were 160.2p per litre, up from 123.7p a year earlier, and the highest average price ever recorded

Energy prices have also rocketed recently (and many suppliers have gone out of business) because of constraints in gas supply, which caused Ofgem to raise its price cap at the beginning of this month. The ONS said that has resulted in price rises of 19.2 per cent for electricity and 28.3 per cent for gas.

Second-hand cars were another factor: prices have risen because the global shortage of semiconductors has slowed production of new cars. The ONS said their “upward effect” on prices rose to 0.36 percentage points in February, and was “little changed” in March.

Meanwhile, prices at restaurants and hotels rose by two percentage points between February and March as venues continued to face staff shortages, meaning they are competing on wages, and thanks to the rising price of alcoholic drinks. The ONS said it was the largest change between February and March since it began collecting data in 1988.

These can all be put down to demand outweighing supply – shortages that develop either because there isn’t enough of something, or because everyone wants it.

What does high inflation mean for interest rates?

Interest rates and inflation are often mentioned in the same breath because interest rates are one of the ways central banks (the Bank of England in the UK) can try to limit price rises. The Bank of England’s target is to keep inflation around 2 per cent: any higher, and the cost of living becomes very expensive; any lower and prices (and wages) stagnate.

Traditionally, central banks increase interest rates when inflation is high. That means borrowing becomes more expensive, and people and businesses are rewarded for saving, so spending falls, reducing demand and causing prices to drop. Last month the Bank of England hiked rates to 0.75 per cent – expect it to rise again at its meeting in May.

Will high inflation cause house prices to fall?

Inflation is essentially the measure of how much of something a currency can buy. In the short term, rising prices of materials such as timber may mean that the price of new builds rises slightly.

But UK house prices have been enjoying an uninterrupted rally since a dip just after the sub-prime mortgage crisis in 2008. That’s because the government has used a range of methods to provide cheap debt (or even free debt, in the case of the Help to Buy scheme), ensuring the housing market has been kept more or less constantly buoyant.

The one thing that could interrupt this would be an interest rate hike by the Bank of England, which would push up mortgage rates. But even if the Bank does hike interest rates, it would have to be a significant rise.

Is this spike in inflation transitory?

The Bank of England has previously insisted that post-pandemic inflation is “transitory” – a temporary rise in prices brought on by the supply chain constraints created by lockdowns and staff shortages. That argument is being used by central bankers on both sides of the Atlantic.

Some economists don’t agree: the supply chain constraints created by the pandemic are likely to continue for much longer. The rise in car prices, for instance, is likely to carry on for a while – the chief executive of Daimler has said the chip shortage could last well into 2023, meaning the price of second-hand cars will continue to stay high. In November, gas prices soared by 17 per cent in a day.

But at a session of the Treasury Select Committee on 15 November, Bank of England governor Andrew Bailey insisted it was short-term inflation: “We have had a period of goods-intensive demand, because some important parts of the service sector have effectively been closed down. That rebalancing is happening, but not as rapidly as we probably thought it would. That of course is putting strain on the supply chain system,” he said.

So do I need to start panic buying?

Inflation is going to keep rising this year, the IMF has said – so prices will keep going up. But panic-buying will only increase demand while supply stays the same, causing prices to rise even faster, so for now, keep your hoarding to a minimum – or, dare we say it, buy less.